GRAT Trust: Section 7520, IRC 2702, and Tax Treatment

A grantor retained annuity trust, or GRAT, is an irrevocable trust that lets you move future appreciation on assets to your heirs while paying little or no federal gift tax. You put assets into the trust, receive fixed annuity payments back over a set number of years, and whatever value remains at the end passes to your beneficiaries. With the federal estate and gift tax exemption at $15,000,000 for 2026 and a top estate tax rate of 40%, a GRAT trust remains one of the most effective tools for shifting growth out of a taxable estate.¹²

The Bet at the Center of the Structure

You place assets into an irrevocable trust and set a term, usually somewhere between two and ten years. During that term, the trust pays you a fixed annuity each year. The annuity is sized so that the total present value of all those payments roughly equals what you put in. That means the “gift” to your beneficiaries at creation is small or even zero.

The bet is that the assets inside the trust will grow faster than an IRS-assumed interest rate. Every dollar of growth above that rate passes to your beneficiaries free of gift and estate tax. If the assets grow at exactly the assumed rate or underperform, the trust simply returns everything to you through the annuity payments and your beneficiaries get nothing. That’s the worst case, and it’s not particularly painful. You end up roughly where you started, minus the legal and administrative costs.

Because the downside is limited, the structure suits assets you expect to appreciate significantly. It’s popular with founders holding pre-IPO stock, owners of fast-growing businesses, and anyone sitting on volatile investments with high upside.

The Section 7520 Rate You Have to Beat

Success or failure hinges on one number: the Section 7520 rate. This is the IRS-assumed rate of return used to calculate what the annuity payments are worth in today’s dollars, and by extension, how large the taxable gift to your beneficiaries is. The rate equals 120% of the federal midterm rate, rounded to the nearest two-tenths of a percent, and the IRS publishes a new figure each month.³

As of mid-2026, the Section 7520 rate sits at 5.0%.⁴ Your trust assets need to grow by more than 5.0% annually for the strategy to transfer anything to your beneficiaries. A lower rate makes GRATs more powerful because the hurdle is easier to clear. When rates were near zero in the early 2020s, almost any appreciating asset beat the threshold. At 5.0%, you need assets with genuine growth potential.

You lock in the rate from the month you create the trust. You can also elect one of the two preceding months if that gives you a lower rate.

The Structural Rules Under IRC 2702

The rules governing GRATs come from Section 2702 of the Internal Revenue Code and the Treasury regulations at 26 CFR 25.2702-3. If you don’t follow them precisely, the IRS will value your retained interest at zero, which means the entire amount you transferred becomes a taxable gift.⁵

To qualify, the trust must meet these structural requirements:

Once you create the trust and transfer assets, you cannot dissolve it or take the assets back outside of the scheduled annuity payments.
The annuity must be a stated dollar amount or a fixed percentage of the initial fair market value of the property you transferred. The annual payment can rise over time, but not by more than 120% of the prior year’s payment.
Payments must be made at least once per year. Anniversary-date payments must be issued within 105 days of the anniversary.
The trust document must prohibit you from adding more assets after the initial funding.
While the annuity term is running, the trust cannot make distributions to anyone other than you.
Neither you nor the trustee can collapse the annuity early by prepaying the remaining amounts in a lump sum.
The trustee cannot satisfy annuity payments by issuing a promissory note or similar debt instrument.

These restrictions come directly from the Treasury regulations and are non-negotiable.⁶

What to Put Inside

You want assets that are likely to outperform the 7520 rate, and ideally by a wide margin. Common choices include shares in a private company before a liquidity event, commercial real estate in appreciating markets, and concentrated stock positions with high expected volatility. Volatility actually helps here, because the GRAT captures the upside while the annuity structure limits the downside.

Hard-to-value assets like interests in private businesses or partnerships require a qualified appraisal to establish fair market value at funding. The initial valuation matters enormously because it drives both the annuity payment size and the taxable gift calculation. An aggressive valuation the IRS later challenges can unravel the structure.

When you contribute a partial interest in a private business, the appraised value may reflect discounts for lack of marketability or lack of control. A minority stake in a private company is worth less than its pro rata share of the total business value, because the holder can’t force a sale, set dividends, or control management. These discounts reduce the amount you’re deemed to have transferred, which means a smaller taxable gift and smaller annuity payments, leaving more room for appreciation to pass to your beneficiaries.

Setting Up and Funding the Trust

Creating a GRAT involves several concrete steps, and sequence matters because the IRS examines whether each requirement was met at the right time.

The trust agreement is drafted, executed, and typically notarized. The document locks in the annuity amount, the trust term, the beneficiaries, and all the structural provisions required by the regulations. Once signed, the trust is irrevocable.

You then retitle the chosen assets from your name into the trust’s name. For securities, that means moving them into a brokerage account held by the trust. For real estate, a deed is recorded. For partnership or LLC interests, the operating agreement and ownership records are updated. The transfer date becomes the valuation date.

After funding, you must file IRS Form 709, the federal gift tax return, for the year of the transfer. This is required even if the annuity is structured to “zero out” the gift, because you’re still transferring property to a trust in which you hold an interest.⁷ The return reports the fair market value of assets transferred, the calculated value of your retained annuity, and the resulting taxable gift, if any. Skipping this filing is a common and costly mistake, because the statute of limitations on the IRS challenging the valuation doesn’t start running until you file.

The Power to Swap Assets

Most GRAT agreements include a provision letting you swap assets in and out of the trust, as long as you replace them with property of equal value. This power comes from Section 675(4)(C) and is what keeps the trust treated as a “grantor trust” for income tax purposes.⁸ The practical benefit is significant. If one asset has appreciated heavily and you want to lock in that gain for your beneficiaries, you can substitute in a less volatile asset of the same current value. The original appreciated asset returns to you at its current fair market value without triggering a taxable sale.

How a GRAT Is Taxed

Income Tax

A GRAT is a grantor trust, which means you personally pay income tax on all the trust’s earnings, including dividends, interest, and capital gains. This is a feature, not a bug. Because you’re paying the trust’s tax bill from your own pocket, the assets inside the trust grow without being reduced by taxes. Those tax payments are not treated as additional gifts. The result is a larger pool of wealth that ultimately passes to your beneficiaries.⁹

Gift Tax

The taxable gift is calculated at the moment you fund the trust. It equals the fair market value of the assets transferred minus the present value of your retained annuity stream, discounted at the Section 7520 rate. By setting the annuity high enough, you can reduce the gift to nearly zero. This is the “zeroed-out” GRAT, which the Tax Court validated in Walton v. Commissioner in 2000.

Even a zeroed-out GRAT typically produces a tiny taxable gift, a few dollars or a few hundred dollars, because the IRS requires the remainder interest to have some value. That small gift counts against your $15,000,000 lifetime exemption, but it’s negligible.¹

Estate Tax and the Mortality Problem

If you survive the full trust term, everything remaining in the trust after the last annuity payment is completely outside your taxable estate. All of the appreciation above the 7520 rate escapes both gift tax and estate tax. That is the payoff.

If you die before the term ends, the picture changes. Under Section 2036, some or all of the trust assets get pulled back into your gross estate because you retained the right to receive income from the property during a period that didn’t end before your death. The exact amount included depends on the annuity structure and how much of the term remained, but the estate-planning benefit is lost for whatever portion is included.¹⁰

This mortality risk is the single biggest vulnerability of the strategy, and it directly affects how you choose the trust term. A longer term gives assets more time to appreciate but raises the chance you won’t survive it. A shorter term is safer from a mortality standpoint but requires faster asset growth to beat the 7520 hurdle.

Rolling GRATs

The common way to manage mortality risk and capture market volatility is the rolling GRAT strategy. Instead of one long-term trust, you create a series of short-term GRATs, typically with two-year terms. When the first trust makes its annuity payment, you use those funds to seed a new two-year GRAT. The process repeats, creating an overlapping chain of trusts.

A two-year term means you only need to survive two years for each trust to succeed. If you die, only the assets in the currently active GRATs get pulled into your estate, not everything from a single long-term trust. The structure also captures volatility more efficiently. If the market surges in one period, that GRAT locks in the gain for your beneficiaries. If the market drops, the GRAT simply fails and returns the assets to you with minimal gift tax consequences, ready to be recycled into the next trust.

The downsides are real but manageable. Each new GRAT requires legal drafting and administration, which means recurring costs. And because each trust uses the 7520 rate in effect at the time of creation, you don’t get to lock in a favorable rate across the chain. In a rising-rate environment, each successive GRAT faces a higher hurdle.

Not a Tool for Skipping Generations

One limitation catches people off guard: you cannot allocate your generation-skipping transfer (GST) tax exemption to a GRAT while the annuity term is running. Section 2642(f) creates an “estate tax inclusion period” that blocks the allocation. Because you retain an annuity interest that would cause estate inclusion under Section 2036 if you died, the IRS won’t let you use GST exemption on the trust until that risk expires at the end of the term.¹¹

GRATs therefore don’t work well for transferring wealth directly to grandchildren or more remote descendants in a GST-tax-efficient way. By the time the inclusion period ends and you can allocate exemption, the trust assets have already appreciated, so it costs more exemption to shelter them. Many planners route the GRAT remainder into a separate trust for children and use other vehicles for generation-skipping transfers.

When the Term Ends

At the end of the annuity term, the trustee makes the final scheduled payment to you and distributes whatever is left to the named beneficiaries. The remainder can go directly to individuals or, more commonly, into a separate irrevocable trust for their benefit. Distributing into a follow-on trust lets you maintain some structural protections, such as creditor shielding and controlled distributions, rather than handing beneficiaries a lump sum. Once assets are retitled and the final tax filings are complete, the GRAT terminates.

Watch the Legislative Calendar

GRATs have been a legislative target for years. Multiple budget proposals would tighten the rules: a minimum term of 10 years (eliminating the popular two-year rolling strategy), a maximum term tied to the grantor’s life expectancy plus 10 years, a ban on annuity payments that decline over time, and a requirement that the remainder interest be worth at least 25% of the contributed property’s value or $500,000, whichever is greater.¹²

None of these proposals have been enacted as of 2026, but they resurface regularly. The minimum-remainder requirement would effectively kill the zeroed-out GRAT by forcing a meaningful taxable gift at creation. A 10-year minimum term would sharply increase mortality risk and reduce the strategy’s appeal for older grantors. Existing trusts would likely be grandfathered under any new legislation, but the window for the current rules may not stay open indefinitely.

1
Internal Revenue Service. What’s New — Estate and Gift Tax
2
Congress.gov. The Estate and Gift Tax: An Overview
3
Office of the Law Revision Counsel. 26 USC 7520 – Valuation Tables
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Internal Revenue Service. Rev. Rul. 2026-11
5
Office of the Law Revision Counsel. 26 US Code 2702 – Special Valuation Rules in Case of Transfers of Interests in Trusts
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eCFR. 26 CFR 25.2702-3 – Qualified Interests
7
Internal Revenue Service. Instructions for Form 709 (2025) – Section: Who Must File
8
Office of the Law Revision Counsel. 26 US Code 675 – Administrative Powers
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Office of the Law Revision Counsel. 26 US Code 671 – Trust Income, Deductions, and Credits Attributable to Grantors and Others as Substantial Owners
10
Office of the Law Revision Counsel. 26 US Code 2036 – Transfers With Retained Life Estate
11
Office of the Law Revision Counsel. 26 US Code 2642 – Inclusion Ratio
12
Tax Law Center. Grantor Retained Annuity Trusts